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Monday, August 08, 2011

Household financial choice of the hapless households of India

In February 2010, I had the opportunity to visit
Pudhuaaru KGFS in Thanjavur. This is a remarkable project which
helps us see the interface between households and the financial
system in a wholly new light.

What a difference 17 months makes! On that visit, I had found a
little tenuous Reliance CDMA cover at one place in Thanjavur city. On
this visit, I found 3g or Edge cover in many remote places. On that
visit, the ride from the airport at Tiruchirapalli to Thanjavur took
two hours. This time, it got done in 30 minutes on the new NHAI road,
with a peak velocity of 110 kph. While there are many reasons to be
gloomy about the problems that India faces, some things are
moving along merrily.

The KGFS approach to households and finance

KGFS emphasises the very important idea that for households to
correctly engage with the financial system, this relationship must be
(a) rooted in high quality advice, (b) which is grounded in a state of
strong information about the household. The first is achieved by
focusing on the incentives of the front line staff, by pushing them to
think about household financial choice in its entirety instead of
thinking about one product at a time, and by having no sales
commission.

The removal of asymmetric information matters in many ways. On one
dimension, if credit is extended to the household, a state of high
information helps ensure better credit decisions. But more generally,
across an array of financial products, when the advisor knows a lot
about the household, the advisor would be able to synthesise an
appropriate mix of sophisticated financial products which add up to an
improvement in household welfare. In time, the advisor will
increasingly lean on an expert system to help him do this better: it's
a good approach today and it will get better in coming years.

I think there is enormous value in this approach. I believe that
KGFS is doing a great job of building this kind of information about
households in their present rollout (which involves going into really
small villages at three locations, in Thanjavur, in Uttarakhand and in
Orissa).

The typical KGFS front-end is a three-man branch in a village,
where the three employees live in that very village. Remote villages
in India are an environment of radical transparency. The households
are relatively trusting. The three people in the outlet know an
incredible amount about the households that surround them. Households
and dwellings in small villages are rather stable: there is relatively
little action through migration / change in financial conditions,
etc. If there was ever an environment where asymmetric information is
being removed, it is this.

The line between household finance and small business finance
cannot be drawn. An adaptation of the KGFS approach can be quite
effective with small business also: the KGFS branch would obtain a
full picture of the firm, and deliver a portfolio of financial
services to it.

A nice feature of the places where KGFS branches are being rolled
out is the lack of alternatives. At a time when Indian financial
regulation does not do much to check the behaviour of conventional
financial distribution, a few high pressure sales agents can queer the
pitch for the KGFS staff. By being in remote places that are being
ignored by distributors, the KGFS staffpeople have the luxury of
dealing with households without the households being tugged by various
high pressure sales tactics of rival sales agents.

Urban households are being mistreated by finance

I also realised some limitations of this approach. Looking forward,
India is urbanising. At first blush, it may appear that there is a big
problem with the utilisation of finance in rural India. But there are
big problems with the utilisation of finance in urban India.

The urban middle class and upper class is deluged with sales
pitches by a variety of sales agents of financial firms. But these
agents are almost always mis-selling, given their drive to push a
product (through commissions) and given their lack of knowledge about
the household's overall financial problem. Almost all financial
products that are pushed in India (i.e. sold and not bought) seem to
be mis-sold. I also feel that when the conversation between a sales
guy and the household is about a product and not the overall
household financial choice, it is almost always leading to the wrong
answers. It's tantamount to a salesman who sells a drug without
knowing anything about the patient.

What is out there, in urban finance, is a scandal, and I am
embarassed to be an accessory to the crime (in however peripheral
fashion). While in Thanjavur, I got the odd sense that at its best, a
rural household that's well connected to a local KGFS outlet is doing
better on utilising the power of finance, when compared with
most urban households who are victims of the sales practices that are
mainstream in Indian finance.

In this sense, the real problem for India is not the tawdry state
of financial inclusion of the very poor in remote places. The real
problem for India -- one that influences the bulk of Indian GDP and
the households that matter greatly for India's growth -- is the tawdry
state of financial planning of the typical urban household.

The KGFS approach is valuable and important to the places where
it's being rolled out. But the burning challenge is that of fixing the
mainstream. The mode of India is not brutally poor and isolated; it is
middle class urban. Improving the interface between middle class and
urban households, and the financial system, matters on a GDP
scale.

An unrelated rumination: How important is rural deprivation in thinking about India?

The discussion above is a recurring theme in Indian economics. A
variety of incentives (development journals, first world aid agencies,
government rhetoric) make it fashionable to emphasise rural
deprivation. But India is changing and the sweet spot has shifted. The
emphasis on poverty and rural is increasingly off-centre. To stay
relevant, and do the most important things in today's India, we have
to keep our eye on the ball.

To fix intuition, it's useful to look at the distribution of annual
household income, over April 2010 to March 2011, from the CMIE
household survey of 143,000 households:

Percentile

Household income

10

45,700

20

59,900

30

72,800

40

90,000

50

112,200

60

142,500

70

180,000

80

240,000

90

348,500

As an aside, I think it's useful for anyone who thinks about India
to memorise these nine numbers. Or atleast memorise these three
numbers: the 25th percentile is Rs.66,000; the median is Rs.112,200
and the 75th percentile is Rs.208,500.

Middle India today has a household income from Rs.66,000 a year (at
the 25th percentile) to Rs.208,500 a year (at the 75th
percentile). The old-style Indian story of rural deprivation is
(roughly speaking) about the 20% of households who are below Rs.59,900
a year (and the size of that group is shrinking). The main story of
India is about the remainder.

An emphasis upon exotic poverty is as misplaced, in thinking about
today's India, as an emphasis on designer clothes. Perhaps a bit
worse, looking forward, since the extremeties of deprivation are being
extinguished by growth, while designer clothes are a superior
good.

Urban households are a much harder problem

So it's natural to ask: How can the KGFS approach be applied to
urban India? When dealing with the urban poor and middle class, it
seems that things are much harder.

Rural households tend to be more trusting, particularly in an
environment of ethnic homogeneity and the repeated game that prevails
in the village setting. But in urban India, households are more
skeptical given the lack of ethnic ties and given the greater
experience with people who have finked in prisoner's dilemmas.

Rural households tend to be a stable household in a stable dwelling
place. Urban households tend to be physically mobile with greater
fluctuations in the household composition.

Until deeper reforms on consumer protection take place in Indian
financial regulation, urban households will be constantly tugged by
unscrupulous sales agents of financial firms pushing products based on
high pressure tactics Even if a KGFS tried to be patient and thorough,
the very presence of such high pressure sales tactics would
contaminate what a KGFS and its ilk can do.

It is relatively easy to construct information about the economic
environment of a farming household (though seasonality and revenue
volatility is a serious concern). I feel it may be relatively hard to
even put together a picture of an urban household, particular when
there is informality of labour supply coupled with
entrepreneurship. This makes it difficult to do financial planning for
such households.

On the other hand, in urban India, the revenue per household would
be higher, and perhaps households could be persuaded to pay for advice
qua advice. Or, the government could move on giving out advice
vouchers to households, thus spurring the rise of an unconflicted
advice industry.

Summary

I think KGFS is a great approach and it will be fascinating to
watch them execute their agenda in the really remote places of
India. What they are doing is path-breaking and important. This should
help us set our sights higher on the problems of urban India. I
have traditionally felt gloomy, in the knowledge that most households
in India are being scammed by the agents selling financial
products. As I look at KGFS, I find myself thinking: Can't we do
something like this in mainstream India? I think this is an
important question to ask. At the same time, there are some visible
hurdles which suggest that this will be hard.

2 comments:

Your take on replicating a model in urban india being difficult is spot on. However if there are enough number of firms (with a scalable model) out there who want to genuinely give a holistic advice through a fee based approach (low affordable fees), then this can be achieved overtime.

But for any company to replicate a KGFS in urban India will take a lot of hardwork and grinding. Whoever is able to create that trust in the urban Indians will have a first mover advantage.

An analogy - A rich guy who wants to have dinner outside may go to a 5star hotel and get served very well. A young college guy who wants to have dinner outside may be happy to hop over to a mcdonalds outlet. Both have satisfied their hunger. One paid 1000 bucks and had to wait 30 mins for the food to be served the other paid 100 bucks and had to wait 1 min for the food. Both trust the brand equally and would recommend their friends.

In financial advisory, advising the rich guys is overcrowded (read, private bankers, wealth managers etc.) while it is the urban youth (25-35) who are in numbers but deprived of quality advice. And they don't mind a mcdonald kind of a service which is easy on pockets but reliable. If doctors at aravind eye hospital can do a wonderful job in such a high intensive segment there is no reason why it cannot be done in financial services. for each family an initial effort of 2-3 hrs can help a long way.

We plan to do this at Futurewise with holistic, unbiased financial planning advice at rs.299 per month.

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